What do you mean by asset allocation? Can even a small investor follow it?
Asset allocation is the process of deciding how to spread your investable money across various asset categories such as equity mutual funds, debt mutual funds and cash. Using this principle, investors can minimise volatility and maximise their returns. The process involves dividing your money among asset categories that do not all respond to the same market forces in the same way at the same time. Asset allocation could vary from one investor to another. It is determined based on your age, lifestyle, goals and risk-taking appetite. For example, an young and aggressive investor can hold 75 per cent in equity mutual funds, 20 per cent in debt mutual funds and 5 per cent in gold.
How does an investor decide what his ideal asset allocation should be?
Before beginning to make investments, a financial planner suggests an asset allocation based on his assessment of an investor’s risk profile. For example, an investor holding a Rs 10-lakh portfolio could have 75 per cent allocation to equity mutual funds, 20 per cent to debt products and 5 per cent to gold. While this is the starting point, this needs to be tracked regularly. After a year, if due to a rise in the stock markets, equity mutual fund allocation rise to 80 per cent, it should be brought back to its original level of 75 per cent. This is necessary as otherwise if equities fall due to an untoward event, it could result in a higher loss to the portfolio. Wealth managers said sticking to an asset allocation plan is crucial to achieving financial goals. This approach reduces risk on the portfolio too. Typically when equity in the portfolio goes up, it can be brought down by switching some equity funds to debt funds. Similarly, when equity allocation falls due to a fall in the market, it can be increased to his original allocation by switching from debt funds to equity funds.
What are the benefits of following asset allocation?
It is difficult for any individual to predict which asset class goes up when or to time the markets. For example, equities may be up, while debt may be down and vice versa. However, if you have your wealth spread across assets, you will be less hit and get the best risk-adjusted returns. Wealth managers believe in the long term, 90 per cent of the returns can come through following the principle of asset allocation.
How often should one review asset allocation?
Asset allocation is sacrosanct to the success of any financial plan. Investors should review it at least once a quarter. If it moves up or down by 10 per cent of their targeted allocation, investors should rebalance their portfolios.